California Will Probably Suffer a Budget Hit for Taking a Flyer on Facebook

Facebook did more than break the hearts of investors when its IPO tanked.

Governor Jerry Brown factored a tax windfall of $1.9 billion over two years into his budget calculations through 2012-13, based on a Facebook trading price of $35 per share. The stock’s opening price at its initial public offering in May was $42. The price fluctuated between $38 and $45 before plummeting. As of August 1, it was trading at $20.88.

This wasn’t supposed to happen. Forbes was predicting just days before the big event: “No doubt about it, the state of California will get a tax windfall from the Facebook IPO.”

Of the $1.9 million it was hoping to collect in tax from sales of stock, $400 million would only be collected if the governor’s tax initiative was approved by voters in November.

The state estimates are not based on anticipated trading by individuals. Almost all of the assumed taxable income events are from stock-related transactions already disclosed by the company in its IPO documents and scheduled to take place, according to the state Legislative Analyst’s Office. Facebook CEO Mark Zuckerberg was said to have stock options for 60 million shares, and 280 million restricted shares were scheduled to be released to employees before year’s end.

The Legislative Analyst’s report speculated that weakness in Facebook stock might motivate heavily invested insiders to sell their shares in 2012, thereby generating unexpected cash flows. But the office acknowledged that, “If, however, the lower share prices persist through November and December, hundreds of millions of dollars of income tax revenue assumed in the state budget plan are at risk.”

The Legislative Analyst tempered its remarks about the state, in essence, playing the stock market, by pointing out that the budget is also whipsawed by “volatile trends in the overall stock market, trends in consumer confidence, and the economic situation in parts of Europe and Asia.”

So why add to the volatility by factoring in Facebook tax revenues before an IPO? The Legislative Analyst offered a mostly circular explanation that it knew there would be some revenue and was “accordingly, given the goal of developing an accurate revenue estimate.”